Sooner or later in your real estate investing career, you’ll find yourself having to decide which of several promising markets to purchase investment properties in. Each property provider (home builder, turnkey provider, real estate agent, etc.) will tell you their market is the best and why you should invest there. As an investor, you need a way to do a real estate market analysis so you can decide which is the best place to invest.
To help you, we’ve broken down the questions you need to ask so you can understand the attributes of a good market and how to do a real estate market analysis for yourself.
A Real Estate Market Analysis
Step 1: Initial Screen
The goal of the initial screen in a real estate market analysis is to quickly eliminate markets that aren’t a good fit. Doing this will allow you to focus your time and energy on more promising markets. This step can take as little as 10 minutes once you’ve done a few. For this exercise, I chose three deal-breaker questions for my initial screen.
#1: Do the numbers work?
My first screen when doing a real estate market analysis is to verify if the numbers “work” in this market.
Some markets have a poor rent-to-value ratio, i.e., meaning the rents are low relative to purchase price, so you’ll have negative cash flow. That doesn’t work for me. I want a market where the properties pay for themselves while I’m building equity.
To illustrate, compare the metrics for San Francisco, CA vs. Port Charlotte, FL, near Ft Myers:
While this is an extreme example, it illustrates how the numbers don’t work for a city like San Francisco. The purchase price is so high relative to the rent that it has negative cash flow of almost $5,000 per month.
The 1% Rule
The old rule of thumb was the “1% rule,” which states that, ideally, you’d want the monthly rent to equal 1.0% of the property’s purchase price, e.g., $1,000/month for a $100,000 property. That 1.0% ratio is very hard to achieve in today’s market, but at current interest rates, a property would need a rent ratio of at least 0.6 or higher to break even. The Port Charlotte property has a rent ratio of 0.67 ($2,300/$345,000).
(Also note that, for the same amount of money, you could buy four brand-new houses in Port Charlotte for the price of one 100-year-old house in San Francisco!)
For me, the numbers on the San Francisco property just don’t work. Imagine losing your day job and having that much negative cash flow! That said, a lot of people have made a lot of money in California real estate by accepting the negative cash flow and banking on price appreciation.
If you’re less risk-averse than I am, just remember that you’re getting a sure thing (negative cash flow) in exchange for a not-so-sure thing (future appreciation).
Also, if you’re looking at properties that have only $200/month in negative cash flow, you may decide you can live with that. You have to decide what numbers work for you or not.
Investor Tip
- Whoever is selling you the rental property should provide a proforma real estate statement itemizing rents and net cash flow after expenses. Be sure to ask for this information.
- Check the housing and rent prices in the same zip code you’re considering buying in by going to Zillow.com. This will help you confirm that the seller’s numbers are realistic. For more information about this process, read this article on how to analyze a real estate deal using a pro forma statement.
#2: Is There Good Property Management?
The most common reason real estate investments fail is poor property management, so I always recommend investors identify at least two good property managers in any given market. That way, if the first one doesn’t work out for whatever reason, you’ve already identified a backup.
The property management company should be a real company, not a mom-and-pop operation out of someone’s house. There should be a “deep bench” of managers, leasing agents, handymen, etc., so service won’t be interrupted if someone’s on vacation or if there’s personnel turnover.
Note: Requiring two good property management companies may effectively eliminate smaller metros. It’s hard enough to find one good property management company, but finding two such companies in a metro area with a population of less than 100,000 can be difficult.
Investor Tip
- Your property provider should have a recommended property management company, so you should evaluate them and see if they’ll work for you. To find a second (backup) property manager, you can:
- Go to Yelp.com, search for “residential property management” and “city name,” and look at the ratings. Many will have negative ratings from disgruntled tenants, so focus on the ratings by landlords.
- Go to Meetup.com and search for real estate investor clubs/groups in the area where the property is located. Then, email the Meetup Group organizer and ask for recommendations.
2. If you can’t find at least one and preferably two suitable property management companies, then you should stop there and pass on that market.
#3: Is the Economy Diverse?
Not having a diverse economy is a deal-breaker for me personally, so I’m including it in this initial real estate market analysis screen. If it isn’t a deal-breaker for you, you could save this attribute for the next section.
My reasoning is that single-industry metros like Detroit or Las Vegas tend to get hit harder during recessions. When times are bad, the first thing consumers cut back on is discretionary spending, such as a new car or a trip to Vegas.
Worrying about whether my tenants will lose their jobs with every downturn in the economy is one more wild card I don’t want to deal with. I want to limit the number of variables outside my control.
Investor Tip
You can determine how diverse a local economy is by going onto Google and searching on “city name” plus “top 20 employers” and look at the number of jobs in each industry. For example, compare the results of Atlanta vs. Detroit:
Atlanta’s major employers are all in different industries: Delta Airlines, Home Depot, UPS, Coca-Cola, Emory University, Center for Disease Control, SunTrust Bank, Georgia Tech, AT&T, Marriott and countless hospitals.
By contrast, although it’s trying to become more diverse, the bulk of jobs in Detroit are still in the auto industry: Ford, Fiat-Chrysler (Stellantis), General Motors, Magna International (auto supplier), Quicken Loans and health care.
With a diverse economy like Atlanta’s, if one sector of the economy is struggling (e.g., Delta Airlines during the COVID-19 pandemic), then other sectors of the economy can pick up the slack. That makes for a more resilient market with more stable rental occupancy and cash flow for investors.
Step 2: Real Estate Market Analysis Deep Dive
At this point, we’ve eliminated the markets that don’t meet our initial real estate market analysis screen without investing too much time. Now, we can do a deeper dive into the semi-finalists that passed our initial screen.
#4: Is There Job Growth?
New jobs in an area are a bullish sign for that area’s growth because someone has determined that the business climate there is promising enough to make the investment.
For example, Intel is currently building a chip factory just northeast of Columbus, Ohio, that will create 3,000 jobs starting in 2025. Those high-paying jobs will pump lots of money into the local economy, including its real estate.
This is the kind of market you want to invest in.
Investor Tip
- The seller of the property you’re investing in will have information if jobs are moving to the area as part of his “pitch” for why it’s a good place to invest.
- Check the city’s Chamber of Commerce website for press releases about new jobs.
- Google “what companies are expanding in “+ “city name.”
- Make sure you locate where the new jobs are coming from on the map. An Intel plant northeast of Columbus will likely have no effect on housing demand in southwest Columbus. Consider commuting distance and traffic patterns when determining where to invest.
#5: Is There Population Growth?
Though job growth usually results in population growth, the two are not always in sync, so they should be tracked separately.
For example, parts of Florida are popular destinations for retirees, so their population growth is greater than their job growth, since retirees don’t need jobs. In other places with high unemployment, like Detroit, a new Amazon warehouse might create new jobs but not increase the population because there are enough unemployed people there to absorb any job creation.
A growing population is important because it means demand for housing will go up, which means rents and property values will likely go up too.
Investor Tip
- Again, whoever is offering to sell you the property should have information on population growth.
- Other information sources vary from city to city, so Google searches are your friend here.
- To save you time, here’s a list of the top 40 fastest-growing metros in the US from 2023 to 2060. Note that The Villages, FL (the largest retirement community in the country) is #1.
Sometimes, you can find city-specific information by searching “city name” + “population growth forecasts.” Here’s the Jacksonville, Florida, housing market forecast:
Note that though the rate of growth is slowing (bottom graph), the metro is still expected to grow by 400,000 people in the next 15 years.
Investor Tip
In addition to the quantity of population growth, you should also consider the quality of population growth. Many retirees in Florida bring lots of capital with them, so it’s not just the number of bodies that matters but also the amount of money they can pump into the local economy.
Retirees with money will sell their homes in New York, buy homes in Florida with all cash, and then spend money on restaurants, golf courses and entertainment. Follow the money.
#6: Is the Market Investor Friendly?
Our last desirable attribute for a market is that it be investor-friendly, namely, one that makes it easy for real estate investors to do business.
Some markets have high property taxes (Houston), others require a city inspection every time a property is sold (St. Louis), and some markets have a time-consuming process for evicting non-paying tenants (San Francisco).
While these may not necessarily be deal-breakers for you, you should be aware of the business climate before investing. This is why I’m including this tip for your real estate market analysis.
Investor Tips
Talking with other real estate investors
- Look up Real Estate Investor Associations (REIAs) or real estate investing Meetup.com groups, and find investors who own properties in multiple cities. An investor in only one city knows that market well, but remember, shat they think of as “normal” might be very abnormal when compared to other markets you’re considering.
Working with property managers
- Don’t ask your property manager, “Is this city investor-friendly?” because they may not have anything to compare it to. Instead, ask very specific questions, such as:
- How long does it take to evict a non-paying tenant? What’s the process and how much does it cost?
- Does the city require periodic inspections? How long does that take to schedule and complete?
- How often are property taxes reassessed?
Then compare those answers to the answers from other markets you’re considering and decide what market you’re most comfortable with.
That’s it!
This back-of-the-envelope real estate market analysis may seem like a lot of work at first, but after you’ve done it a few times, you’ll find you can do your initial screening in about 10-15 minutes. The deeper dive could take a little longer.
Performing this analysis will give you the confidence you need to get out of “analysis paralysis” and start investing in real estate.
Final Thoughts
Few markets will “check all the boxes” and provide the perfect place to invest. If there was such a market, it’d be too hard to get property there because all the Wall Street private equity funds would be snapping them up.
You’ll have to decide for yourself what criteria are your “deal breakers” and then use them on your initial screen.
The only non-negotiable, in my opinion, is property management. If you can’t find good property management, your investment is almost certain to fail. All the other criteria are up to you.
But knowing that the numbers work, that there’s good property management, a diverse economy, job and population growth and an investor-friendly environment will help you pick the best markets for you.
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